I've written about Brazil pre-Lula and post-Lula and spent the last five years covering all aspects of the country for Dow Jones, Wall Street Journal and Barron's. Meanwhile, for an undetermined amount of time, and with a little help from my friends, I will be parachuting primarily into Brazil, Russia, India and China. But will also be on the look out for interesting business stories and investing ideas throughout the emerging markets.

Is China's Ownership Of U.S. Debt A National Security Threat?

Is China‘s ownership of nearly $1 trillion in U.S. Treasury debt a threat to our national security?

I’ll start with the short answer in case you want to go on to LOL Catz…no, it is not a threat.

Such is the assessment of the U.S. China Business Council (USBC), a lobby for U.S. multinationals doing business in China. Oh, you jest, you might say. What do you expect a pro-China lobby to say?

Consider this, the U.S. has around $16 trillion in outstanding debt and most of it is held by us, and the bulge bracket banks here at home: Goldman Sachs, JP Morgan, Citibank, Bank of America. Around 7.5 percent is held by China, the biggest foreign holder of U.S. debt.

One of the reasons why China has so much Treasury holdings is because of trade. Companies put money in short term Treasury notes and bills to settle trade payments. China’s government could also call all of its own holdings and demand full payment of the money it lent us in principal plus interest, but under what circumstance would they do such a thing?

It would be a national security risk if China held a position where they could dictate U.S. policy on fiscal and monetary matters. They cannot.

If the economy was crashing and China got terrified and wanted their money back, unless the U.S. defaulted, it would hand it over and there would be nothing China would get in return. Moreover, when the U.S. economy was collapsing in 2008 all the way to the 666 low on March 6 in the S&P 500, China never retreated from Treasurys, or demand Congress get its finances in order or else it would choose to buy euros, or gold instead.

The Pentagon did an evaluation on the risks posed by China’s ownership of U.S. debt in July and came to the same conclusion: “Attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the United States.”

The report was sent to congressional committees by Defense Secretary Leon Panetta, who called China’s ownership of U.S. debt non-problematic and non-threatening.

The USBC’s take is that Chinawants its holdings of Treasury debt to gain value, not lose value. And just because interest rates are going down, that doesn’t mean China is losing value on those holdings. Lower interest rates might be bad for income generation, but they mean more demand for bonds, which means higher bond prices.

China wants the U.S. economy to prosper because that means China will be able to continue exporting here. As it is, exports from China to the European Union are all down. Exports to the U.S. are up. China is not in a position to threaten the U.S. with financial “terrorism” of any kind. A decision by China to sell off massive positions of U.S. debt would send the American economy into a downward spiral, harming not only the value of China’s investments, but also China’s export-driven economy.

The bigger issue for the U.S., says John Frisbie, director of the USBC in Washington is the size of our fiscal deficit and the long term implications for the economy, not the level of China’s debt holdings.

“The US-China relationship is fast becoming the most important bilateral relationship for both countries, if it isn’t already,” Frisbie said in a statement on Wednesday. “Its importance is only going to grow. We need to expand our engagement. Importantly, we need to get smarter about China.”

Congressmen Charles Boustany (R-LA) and Rick Larsen (D-WA), co-chairs of the Congressional US-China Working Group, each gave brief remarks. “There is much to be gained in both economic and strategic terms if we get the relationship right, but economic and strategic difficulties lie ahead if we do not,” Larsen said.

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World Gold Council has now confirmed the Chinese are going to back the yuan with gold.

If it is true – to call it The Ground Breaking will be the understatement of the year. Welcome to the Currency Wars at its Prime.

Now all recent Japan and China rhetoric about the “territory conflict” will be put in the very dangerous context. Will They dare to make The War to protect the Status Quo for the doomed “Reserve Currency of Choice” – US Dollar?

Click on the link to the Bloomberg story about the Pentagon report. They said that it was unlikely and would cause “some” damage but that it would be “minimal” if — in the rare case — China (or Japan, or both) opted to call their bonds.

well Ill agree… the US Federal Reserve purchased 61% of the Treasury debt issued by the US Treasury in 2011 using money they printed out of thin air… with all the Quantitative Easing they have been doing over the last 5 years…

im sure the Pentagon thinks they can just buy up that debt as the Chinese dump it…

and your right they dont want to rock the boat with the USA… this is money they have made from their export surplus anyways

but if China wanted to hit the secondary bond markets with its selling it will drop the market… temporarily or not…

I view it as more than temporary as the too big to fail Western Banks…have up to 1.5 “Quadrillion” (at least 600 trillion) in derivatives bets where they can only 2 to 4% of those bets any move in the market temporary or not

they will not be able to cover the margin calls on these loses as their futures markets get slammed…

really I only see the Chinese using this as a weapon… to distract the USA in a brief territorial skirmish with Japan or more likely the Philippines

Dunno, David. That’s insider baseball, anyway, not something us mere mortals outside TSY and the Pentagon will know. At least not til years later when someone writes a book: “We would have said this or did that in favor of Japan but China threatened this and that and the White House backed down.” Until then…we got nothing.

Craziness. I know. Assets securitized by other assets securitized by the securitization….Bain & Company report released in Nov. talks about this and says we have to learn to live with bubbles created by this superabundance of capital.

well we do have precedence…it was said the reason the US government rescued Fannie Mae and Freddie Mac… way back at the height of the 2008

was because foreign bond holders of their long term debt, demanded the US government make good on their debt…

. . The top five foreign holders of Freddie and Fannie long-term debt are China, Japan, the Cayman Islands, Luxembourg, and Belgium. In total foreign investors hold over $1.3 trillion in these agency bonds, according to the U.S. Treasury’s most recent “Report on Foreign Portfolio Holdings of U.S. Securities.”

FreedomWorks President Matt Kibbe commented, “The prospectus for every GSE bond clearly states that it is not backed by the United States government. That’s why investors holding agency bonds already receive a significant risk premium over Treasuries.”

“A bailout at this stage would be the worst possible outcome for American taxpayers and mortgage holders, who have been paying a risk premium to these foreign investors. It would change the rules of the game retroactively and would directly subsidize the risks taken by sophisticated foreign investors.”

“A bailout of GSE bondholders would be perhaps the greatest taxpayer rip-off in American history. It is bad economics and you can be sure it is terrible politics.”